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Does More Equality Mean Less Economic Growth?

“Tax cuts for the wealthiest benefit everyone.” “Though seemingly compassionate, generous government assistance for the poor is unwise.” These and a variety of related policy arguments rest on the notion that equality and economic growth are at odds. Are they?

That the economy would suffer if there were very little inequality is certainly true. To get inequality to a very low level, the government would have to impose high tax rates and redistribute much of the revenue to those who get paid little. Or it could mandate that everyone be paid approximately the same amount. Either option would drastically reduce many people’s motivation to work hard, learn new skills, save and invest, and start new businesses. The result would be a far less dynamic economy.

But most of those who believe inequality in the United States is too high would like less inequality, not no inequality. Hence, the real question is: Would the economy suffer if incomes were less unequal?

Evidence

To answer this question it helps to examine some evidence. We could, for example, look at the experiences of the United States and other similarly-affluent countries in recent decades. A number of studies have found that among poor and middle-income countries, less inequality tends to boost economic growth. But these countries are so different from richer nations in their economic and political institutions that it doesn’t make sense to try to generalize from one to the other.

The following chart includes the seventeen affluent nations for which comparable data are available for inequality and growth over a reasonably lengthy period of time. Income inequality in 1980 (or the closest available year) is on the horizontal axis. It is measured using the Gini index; larger values indicate more inequality. The average rate of economic growth from 1980 to 2005 is on the vertical axis. There is no association between inequality and growth.

What about Ireland? It began the 1980s as a high-inequality country, and it enjoyed by far the fastest economic growth among these nations over the ensuing two and a half decades. Like that of any individual nation, however, Ireland’s story is a complex one, and explanations of the Irish growth miracle seldom attribute any importance to its high level of income inequality.

Of course, the United States is unique in various ways. Perhaps what applies to rich countries in general doesn’t hold for the U.S. in particular. Another source of evidence is the experience of the American states. The next chart shows a similar lack of association across the states.

We also can examine the U.S. historical experience. There are good data on income inequality and economic growth going back to the late 1940s; before then data are less reliable, especially for inequality. Inequality decreased a little in the 1950s and 1960s, but has risen a good bit since then. The following chart shows the U.S. economic growth rate by income inequality for each year from 1947 to 2005. Economic growth is averaged over ten-year periods beginning in the year inequality is measured. (For the year 1990, for instance, inequality is measured during that year and economic growth is averaged over 1990 to 1999.) As with the cross-country and cross-state evidence, there is no indication here of a tradeoff between equality and growth.

(Data used in these charts are from the Luxembourg Income Study, OECD, Census Bureau, and Bureau of Economic Analysis.)

Objections

Is something missing from the picture conveyed by these data? How would a proponent of the notion that more equality means less growth respond?

First, she or he might point out that even Arthur Okun, a respected liberal economist and one-time chair of Lyndon Johnson’s Council of Economic Advisers, admitted that there is a tradeoff between equality and growth. Indeed he did. In his influential 1975 book, Equality and Efficiency: The Big Tradeoff, Okun wrote “Equality in the distribution of incomes … would be my ethical preference. Abstracting from the costs and consequences, I would prefer more equality of income to less and would like complete equality best of all.” But he reluctantly concluded that given the existence of a tradeoff between equality and growth, society ought to forgo greater equality in favor of a healthy economy.

However, Okun’s conclusion was based largely on theorizing rather than evidence. What does theory tell us about the effect of inequality on growth? Until recently the standard view was that there is a tradeoff. Less inequality will produce less investment, because the rich do most of the saving and investing. It also will produce less work effort, because those at the top of the income distribution lose more of their earnings to taxes and those at the bottom can live off government benefits instead of getting a job.

These days, however, it is widely recognized that theory is ambivalent about the impact of inequality on growth. Yes, higher taxes might reduce savings. But if the money is redistributed to the poor, consumption may increase, since the poor tend to spend a larger of their income. Consumption tends to be just as important for economic growth as savings. (High-spending America grew much more rapidly than high-saving Japan in the 1990s.) Yes, generous government benefits may reduce work effort by those at the bottom of the distribution. But generous benefits can have strings attached. In Denmark and Sweden, working-age adults can receive government benefits such as social assistance and unemployment insurance for only a limited period of time, after which they are expected (and helped) to find employment. Furthermore, a relatively egalitarian income distribution is likely to enhance perceptions of justice, potentially boosting work effort while reducing crime and other socially wasteful behavior. Bottom line: to understand inequality’s impact on growth, we have to rely on empirical evidence.

It also is worth noting that Okun wrote at a time, the early 1970s, when the level of income inequality in the United States had reached a historical low and the economy was mired in a recession. Had he been able to consider developments in the U.S. and other affluent countries in the ensuing decades, his assessment might well have been different.

A second line of response is that these charts must be hiding something. It is, of course, possible to mislead with statistical data (as with any other type of evidence). But what, exactly, might these charts be hiding? One possibility is that income inequality and/or economic growth is measured improperly or inaccurately. Another is that choosing a different starting or ending year might change the picture. A third is that taking into account (“controlling for”) other determinants of economic growth could lead to a different conclusion. In a recent book, Egalitarian Capitalism (Russell Sage Foundation, 2004), I considered these objections in some detail. None of them turns out to alter the picture conveyed in the charts here.

A third type of response is that while the level of inequality might not affect economic growth, government action to reduce the existing level, such as raising tax rates on the rich, will. Here the historical experience of the United States is again instructive. Although they aren’t perfect, the best available data suggest that income inequality fell sharply between 1930 and 1950. This was due mainly to higher tax rates, New Deal benefits such as social security and unemployment compensation, legalization of union bargaining rights, and wartime wage controls. In the forties, fifties, and sixties the economy boomed. After holding steady during the 1950s and 1960s, inequality has jumped sharply since the mid-1970s. There has been no upward shift in the rate of economic growth during this period.

Why Americans Are Confused

In 1987, 1996, and 2000 the General Social Survey asked American adults whether they agreed or disagreed with the statement “Large differences in income are necessary for America’s prosperity.” On the one hand, in each of these years only about 30% said they agreed or strongly agreed. On the other hand, fewer than half tended to disagree or strongly disagree. A relatively large share said “neither,” probably because they weren’t sure what to think.

This ambivalence, or confusion, offers a significant opportunity for those appealing to the notion of an equality-growth tradeoff. Claim that a tax cut for the well-to-do will boost economic growth and a sizable share of Americans won’t feel confident in objecting. The idea seems plausible, and social scientists and policy makers have not been effective at communicating the relevant empirical evidence.

In this instance the evidence speaks rather clearly. Is it likely that less income inequality here in the U.S. would result in less economic growth? No.

24 thoughts on “Does More Equality Mean Less Economic Growth?”

There was some interesting figures David Harvey quoted in his Brief History of Neoliberalism on this topic, noting how global growth rates were greater in the more equalising post-war boom than the neoliberal 80s and 90s. Unfortunately, I don’t have the figures to hand.

I keep thinking that the point is not that governments simply impose simplistic policies to achieve ‘equality’, but invest government resources into institutions or enterprises which both have beneficial effects for the nation and also the effect of decreasing relative inequality.

So, for example, in reacting to global warming, one government could choose to invest funds in such a way that the profits from said investment flow entirely to a few existing companies’ executives and shareholders, whereas another government might choose to invest these funds in a clever manner so as to prompt local industrial development, which might be more likely to prompt local spending, hire domestic professionals, etc.

I’m sure someone else could say so more elegantly, but the past 30 years’ worth of Reaganite / New Right spending & investment patterns always seem to favor spending our nation’s wealth in ways which are channeled upwards to an extreme, in no way which is either necessary or wise, at least not from a non-venal way of thinking.

eCAHNomics – This could happen if there were big differences between the states at that time. For example, suppose everyone in California had an income of $100k (for a within-state Gini of 0) and everyone in Nevada had an income of $50k (also for a within-state Gini of 0). The combined California-Nevada Gini would not be 0.

By the way, I don’t see any attempt to control for country-level or state-level fixed effects in these analyses. Cross-sectional comparisons like this don’t answer the question of whether or not an increase in growth is correlated with an increase in inequality.

eCAHNomics – whoops, I gave you an example of the opposite relationship. Here’s the example you want:
Suppose California had one person who made $100k and one person who made $0 (for a Gini of 1). And suppose Nevada had one person who made $50k and one who made $0 (also for a Gini of 1). Now the combined California-Nevada Gini would be less than 1, since you’d have two people with $0, one with $50k, and one with $100k.

So it is possible for the whole country to have a lower Gini than any one state.

One correction: last time I checked, unemployment benefits in Sweden were not limited in time. They are however paid subject to the condition that the recipient periodically shows that s/he is active in looking for employment, and that s/he accepts whatever training that the the public employment agency thinks fit.

Good question. It’s because the data are from different sources. Both are the best available for the respective units, but they differ. The country data are from the Luxembourg Income Study (LIS) and are posttax-posttransfer. The state data are from the U.S. Census Bureau and are PREtax-posttransfer. The latter therefore don’t include the equalizing impact of income taxes and of the Earned Income Tax Credit. Because these policies are mainly federal rather than state-specific, including them wouldn’t change the cross-state differences in inequality much. But it would reduce the Gini in all states.

Very interesting post. Couple things; I think if you go up to 1990 or 1995 there is a weak positive relationship between income and inequality for rich countries – with UK as an outlier (more inequality correlated with higher income). Also I think the mechanism through which redistribution can increase growth is by overcoming credit-constraints faced by lower income households, not by increasing the consumption rate (which pretty much has decrease growth in the long run, unless you’re talking about a poor country stuck in a poverty trap in need of a Big Push).
Finally because both average income, and the gini coefficients come from the same data (individual incomes) – hence from the same, usually left skewed distribution, one should actually expect to see a positive relationship for IDENTICAL countries in the data.

Actually, there IS a set of government revenue policies that promote equality, fairness, AND growth: the taxation of economic rents.

The biggest rent is land and other natural resources. Taxing land heavily promotes equality (because quality land tends to be held by the wealthy), is fair (because the returns to land (“rent”) are captured by the landowner even though the landowner in his role of landowner didn’t create them), and promotes growth (because an increase in taxes on land would enable a decrease in taxes on productive behavior, like laboring or creating capital).

Here’s a question for you. What if we cut the size of the government and did with less “services” and citizens of this great capitalist republic could be free to invest more into what they percieved to be a good investment? We all complain about how poorly govt. manages things (DMV, Katrina, etc.) why do you want to give them more money? Not to mention all those govt. employees living off of my hard earned tax dollars. They aren’t producing anything to make this economy grow.

Sorry buddy, but I have to agree with PJ. Why is it that people in this country are obsessed with taking money from those of us who earn money? Always all this talk about social programs and “helping” people and yet even though we are throwing more money at our problems than ever before, nothing gets better or even slows down? The answer I suspect is rather simple…working hard and keeping the money you earn & contributing to the system by being a consumer of goods works, while taking money from some so that others don’t have to “do” doesn’t. Thats why social programs fail time and again. There is no such thing as a free ride (I’m looking at you Hillary) no matter how you try and divide it up…those who do prosper, while those who wait for handouts don’t. Unless a democrat is in office. I know this will bring about much ire from the left side but it’s only because the truth hurts.

Well, you provide statistics as proof while I offer up what I can plainly see with my own eyes. Until about a month ago when I finally found and bought my first home, I shared a duplex with a 100% welfare family. The “man” of the house, and I use the term loosely here, is 31 years old and has been claiming to be unable to work due to a back problem for about 6 years now. Of course, his back only seems to hurt when it’s time for work but tell him you’re going 4 wheeling, go cart racing or taking the snow mobile and he will run you over to show off his prowess on these machines. Amazing the number of jumps and crap his ‘poor’ back can suddenly take when it’s play time. His wife is 26 and has never worked a day in her life and has been on some sort of public assistance her whole life and proudly brags about how she never has to work because, and I quote, “stupid people like you go to work and pay for me and my kids”. There is nothing absolutely wrong with this woman save her state of mind. Too make matters worse, in my state you get a certain dollar amount per child up to a certain age, so guess who has a new kid every time one reaches that age and the money stops coming? They are up to 4 now and there is no end in sight to this cycle. Do they at least use the money wisely? Heck no! Because it was a duplex in what once was a single family home, bill collectors would often leave their collection notices on our front door (their entrance was in the back) and sure enough they were scamming everyone of the utility companies in the area. Due to liberal, ‘lets save the world’ laws, these companies were forced by law to not turn off basic utilities even though these people made it known they were never going to pay the bills. What do you think that does to prices for things like propane/oil/natural gas and electric? Utility companies don’t just eat those loses, they pass them on to paying customers like you and me. NO they proudly tell anyone who will listen about how they take the money and buy beer, weed and other drugs so they can “hang out” with their good friends…who happen to be living the same bullsh*t lifestyle. Then theres the things you can never see in a statistic, the lessons these people are giving their kids. These kids have absolutely no chance at a decent life mainly because since birth it has been taught to them that this is the way it should be. Their oldest is now 16 and stopped going to school at 14, which means he barely made it through a semester of high school….and he’s proud of it. The 2 younger school aged ones, about 10 and 8 respectively, already show signs of complete indifference towards school. The mother can barely get out of bed to put them on the bus most days and we have heard the complaints of the driver about his totally wold behavior on the bus. I can only imagine what this child is like to have to deal with for 6 hours in a classroom. He is allowed to do what he wants when he wants and is NEVER, EVER told no about anything. Believe me it shows. The only sot these kids have is either someone getting them out from under the influence of these people or some sort of miraculous epiphany occurring in their own little minds pushing them to do something better with their lives. I admit that anything is possible but not bloody likely. NO these kids will grow up to be what they were taught to be and they in turn will have more kids and keep the cycle going. As long as the system stands…they will thrive. This is what happens when people know they don’t have to work because someone will be foolish enough to do it for them. Most parents know enough not to reward bad behavior and when someone in your life has a dependency of some sort, alcohol, drugs, food, etc.. we all know it is bad to be an enabler but funny enough when it’s the state and our tax money suddenly there is no problem with being an enabler. Suddenly it’s humane to help someone screw themselves, their children and every working stiff paying taxes. I also don’t agree that these are ‘isolated cases’ as in my life I have seen this exact scenario played out several times…only the names change. You my friend probably live a respectable life and are more than likely a responsible, contributing to society person, and I applaud you for it, but do not think for one minute that just because you think and act a certain way, that means everyone is like you. The truth in my own opinion is that most people, not all, many for sure are opportunistic in nature and will take a free lunch every time. As long as you are willing to serve it up they will take it and they don’t care what it cost you’re dumb ass to give it to them. (Please note I am NOT calling anyone names here when I say dumb ass, that statement is just a reflection of those kind of people think of working citizens like you and me)

What I have never understood is that if you must feel compelled to reach out and help people, then why not make it realistic? I have to pass a drug test to earn the money used to support these people…why don’t they have to pass one to receive it? There are tons of menial jobs out there under government control…if you need to be on welfare and you have no physical limitations then why shouldn’t you have to report for work to earn that welfare check? Why can’t welfare recipients clean up trash on state and town roads for instance? Local post offices have been complaining about a huge back log in getting passports out…why can’t the welfare crowd earn their keep by helping do clerical work at such places? Any fool can be taught to do what these people do at places like DMV for example. There are tons of state mental institutions where they can use able bodies to do menial stuff from serving lunches to just spending time talking to an elderly person. There are things they can be doing besides sitting at home waiting for a check in the mail if someone just put a little thought behind it. Anyway, sir I’m sure you will fire back with all sorts of statistic this and statistic that, but again I can only hit you with what I see with my own eyes and know from my own experiences.

In India around 40% of people are living in poverty. This means their purchasing power is zero. Suppose by some means in the next 10 yeras we make this 30% , then these people are going to spend their money in purchasing many goods. Is this not good for economic growth? We may have to find out ways of reducing poverty and increasing the purcasing power of people. May be whatever we are doing is not good enough. What about investing more on education? Let us give free meals to the children who are attending the schools.